Euro area exchange rate-based competitiveness indicators: a … · 2012-10-23 · The different...

B. Lauro and M. Schmitz European Central Bank

July 2012 1

JULY 2012

EURO AREA EXCHANGE RATE-BASED COMPETITIVENESS INDICATORS: A COMPARISON OF METHODOLOGIES AND EMPIRICAL RESULTS by Bernadette Lauro and Martin Schmitz,1 European Central Bank This paper will be presented at the Sixth IFC Conference on “Statistical Issues and Activities in a Changing Environment” BIS, 28-29 August 2012 NOTE: This paper should not be reported as representing the views of the European Central Bank (ECB). The views expressed are those of the authors and do not necessarily reflect those of the ECB.

1 We would like to thank L. Nordquist, R. Oliveira-Soares and A. Schubert for very useful comments. Any errors or omissions are exclusively our own responsibility.

B. Lauro and M. Schmitz European Central Bank July 2012

2

ABSTRACT

In light of the increasing policy relevance of competitiveness indicators, this paper

provides an overview of different methodological approaches used by various

international organisations for calculating effective exchange rate indices based on trade

weights. In particular, the paper discusses the trading partners considered in these indices,

the weighting procedure, the trade basis, patterns and updating of trade weights, and the

choice of deflators. In addition, the paper highlights quantitative differences and

similarities among the indices calculated by different institutions. In particular, exchange

rate-based competitiveness indicators as computed by different institutions may not

always deliver the same policy messages.

JEL codes: F10, F30, F31, F40

Keywords: competitiveness, effective exchange rate (EER), nominal effective exchange rate (NEER), real effective exchange rate (REER), harmonised competitiveness indicators, trade weights


July 2012 3

1 INTRODUCTION

Real effective exchange rates (REERs) are often used as measures of international price

and cost competitiveness. They capture broad macroeconomic developments in the

exchange rate and prices or costs and provide a comprehensive assessment of the

international pressures on domestic firms over the medium term in respect of costs or

prices. However, REERs do not include any firm-level data nor do they explicitly reveal

factors relating to non-price competitiveness (such as product quality and reputation). The

high relevance of the real effective exchange rate as a measure of competitiveness is also

reflected by its inclusion in the scoreboard of the EU Macroeconomic Imbalance

Procedure adopted in December 2011 (see European Commission, 2012).

The following dimensions shape REER indicators:

Type of trade to be used as a basis of weights

Group of trading partners

Trade weight computations

Frequency of updating of trade weights

Choice of deflators in order to calculate price and cost competitiveness

REERs as calculated by various international organisations and central banks exhibit

many similarities in their methodology, but also some differences. In this paper, we

analyse REERs as calculated by the Bank for International Settlements (BIS), the

European Central Bank (ECB), the European Commission (EC) and the International

Monetary Fund (IMF). We complement the analysis of these indicators by performing

some simulations where we construct effective exchange rates with specific characteristics

in order to highlight the quantitative impact of certain methodological features.

The remainder of the paper is organised as follows. Section 2 compares the

methodological approaches in calculating REERs focusing on trade weights and deflators.

In Section 3, we present differences between various indicators and identify some of their

drivers. Section 4 concludes.


4

2 OVERVIEW OF METHODOLOGIES

Real effective exchange rates serve as indicators of international price and cost

competitiveness. The REER of the euro is calculated as the geometric weighted average of

bilateral nominal exchange rates which are deflated using relative price or cost measures:

(1)

where N stands for the number of competitor countries in the reference group of trading

partners, teuroie , is an index of the average exchange rate of the currency of partner country

i vis-à-vis the euro in period t, teurod and t

id are, respectively, the deflators for the euro

area and partner country i, and wi is the trade weight assigned to the currency of trading

partner i.2 In the remainder of Section 2, we discuss how trade weights are calculated by

different institutions and which set of deflators are used.

2.1 TRADE BASIS

In general, manufactured goods, commodities and services are the main trade flow

categories. However, most of the available EERs are calculated on the basis of trade in

manufactured goods as classified in Sections 5 to 8 of the Standard International Trade

Classification (SITC). There are several reasons for choosing manufacturing trade. First,

for most countries it accounts for the largest part of total trade in goods and services. For

example for the euro area, manufactured goods had a share of about 61% of total exports

and 49% of total imports of goods and services in 2009. Second, it is generally deemed

being most responsive to developments in competitiveness. In addition, high quality

bilateral data are available for a broad set of countries.

Commodities, on the other hand, are usually considered to be homogeneous goods whose

prices are determined in global markets without being influenced by the competitiveness

of individual countries. Indeed, including trade in agricultural or mining products may

distort the competitiveness analysis, because these goods are often heavily regulated or

subsidised. Data coverage on trade in services is less complete compared to manufacturing

2 Schmitz et al. (2012) provide details on how the effective exchange rates of the euro are computed.

iwN

iti

teuroi

teurot

d

ed

1

,REER


July 2012 5

trade data.3 As a consequence, the ECB’s weighting scheme does not reflect patterns of

trade in agricultural products, raw materials, energy products or services.

Table 1 shows which type of trade is included in the weighting schemes of different

institutions. Besides the ECB (Schmitz et al., 2012) and the BIS (Klau and Fung, 2006),

also the IMF (Bayoumi et al., 2005) uses manufactured goods as basis for the calculation

of a narrow index vis-à-vis 26 trading partners. The IMF’s broad index, vis-à-vis 184

trading partners, is also based on trade in commodities and services. However, services are

effectively included only for those countries with a high incidence of tourism in the total

trade; otherwise, the same bilateral weights for a country as for trade in manufactured

goods is applied. The European Commission (2012) calculates EERs based on total trade

in goods (hence including both manufacturing products and commodities).

Table 1: Overview of type of trade

Institution ECBEuropean Commission

BIS

Trade basis Manufactured goods (SITC 5-8)

Total goodsManufactured goods (SITC 5-8)

Manufactured goods (SITC 5-8)

Manufactured goods (SITC 5-8), commodities (overall weight in global markets), and services (same bilateral weights as manufacturing except for countries where tourism is important)

IMF

2.2 TRADING PARTNERS

The different indicators offer a variety of trading partner composition. It is noticeable that

for most institutions two groups of countries serve as the basis for EERs: a narrow group,

covering mainly industrialised economies, and a broader group, including also emerging

economies. The distinction is often necessary owing to the lack of long time series for data

both on trade and on deflators.

Table 2 shows by differentiating between four groupings of countries which partner

countries are included in the narrow and broad indices of different institutions: first, non-

European countries that represent the major trading partners; second, EU countries that 3 Schmitz (2012) computes experimental EERs based on trade in services for the ECB’s EER-20 group (details are presented in Section 3.3).


6

have not joined the euro area; third, non-EU countries that have lower trade weights with

the euro area; and finally, euro area member states. It is worth noticing that:

Among the major trading partners and non-euro area EU countries, the broad

compositions (B61, EER-40, IC41, published by the BIS, ECB and EC,

respectively), are rather homogeneous, with the exception that the ECB EER-40

group does not include single euro area Member States, while these are counted

individually in the B61 and IC41;4 however, Singapore is missing in the EC’s

indicator.

The BIS and ECB’s broad EERs also include a wide range of smaller trading

partners (with a very similar coverage of countries), while EC indicators do not

account for those.

Narrow groups of trading partners (B27, EER-20, IC36) are more diverse. The

BIS indicator excludes some major non-EU trading partners such as China, most

of the EU countries (not belonging to the euro area), and part of the euro area

Member States. As the EER-20 of the ECB, the B27 indicator does not include

Turkey, while the IC36 does. However the latter excludes China, Hong Kong,

South Korea and Singapore. The ECB EER-20 group does not comprise Mexico

and New Zealand which are however included in the B27 and IC36 indices.

4 Individual euro area Member States are included in the same group for the so-called Harmonised Competitiveness Indicators (HCIs) of individual euro area Member States as explained in Section 2.4.


July 2012 7

Table 2: Overview of groups of trading partners

B61 B27 EER-40 / HCI-40 EER-20 / HCI-20 IC41 IC36Australia Australia Australia Australia Australia AustraliaBrazil Brazil BrazilCanada Canada Canada Canada Canada CanadaChina China China ChinaHong Kong SAR Hong Kong SAR Hong Kong Hong Kong Hong KongJapan Japan Japan Japan Japan JapanSouth Korea South Korea South Korea South Korea South KoreaMexico Mexico Mexico Mexico MexicoNew Zealand New Zealand New Zealand New Zealand New ZealandNorway Norway Norway Norway Norway NorwaySingapore Singapore Singapore SingaporeRussia Russia RussiaSwitzerland Switzerland Switzerland Switzerland Switzerland SwitzerlandTurkey Turkey Turkey TurkeyUnited States United States United States United States United States United StatesBulgaria Bulgaria Bulgaria Bulgaria BulgariaCzech Republic Czech Republic Czech Republic Czech Republic Czech RepublicDenmark Denmark Denmark Denmark Denmark DenmarkLatvia Latvia Latvia Latvia LatviaLithuania Lithuania Lithuania Lithuania LithuaniaHungary Hungary Hungary Hungary HungaryPoland Poland Poland Poland PolandRomania Romania Romania Romania RomaniaSweden Sweden Sweden Sweden Sweden SwedenUnited Kingdom United Kingdom United Kingdom United Kingdom United Kingdom United KingdomAlgeria AlgeriaArgentina ArgentinaChile Chile

ColombiaCroatia CroatiaIceland IcelandIndia IndiaIndonesia IndonesiaIsrael IsraelMalaysia Malaysia

MoroccoPeruPhilippines PhilippinesSouth Africa South AfricaTaiwan Taiwan TaiwanThailand ThailandVenezuela VenezuelaSaudi ArabiaUnited Arab EmiratesAustria Austria Austria Austria Austria AustriaBelgium Belgium Belgium Belgium Belgium - Luxembourg Belgium - LuxembourgCyprus Cyprus Cyprus Cyprus CyprusEstonia Estonia Estonia Estonia EstoniaFinland Finland Finland Finland Finland FinlandFrance France France France France FranceGermany Germany Germany Germany Germany GermanyGreece Greece Greece Greece Greece GreeceIreland Ireland Ireland Ireland Ireland IrelandItaly Italy Italy Italy Italy ItalyLuxembourg Luxembourg LuxembourgMalta Malta Malta Malta MaltaNetherlands Netherlands Netherlands Netherlands Netherlands NetherlandsPortugal Portugal Portugal Portugal Portugal PortugalSlovakia Slovakia Slovakia Slovakia SlovakiaSlovenia Slovenia Slovenia Slovenia SloveniaSpain Spain Spain Spain Spain Spain

BIS ECB European Commission

Ma

jor

tra

din

g p

art

ne

rsE

uro

pe

an

Un

ion

c

ou

ntr

ies

Sm

alle

r tr

ad

ing

pa

rtn

ers

Eu

ro a

rea

co

un

trie

s

Note: EER-20 and EER-40 groups of trading partners do not include euro area member states. These are included in the corresponding groups for the calculation of HCIs-20 and HCIs-40, which represent the harmonised competitiveness indicators for individual euro area countries. Chart 1 compares the trade weights of the ten largest trading partners of the narrow groups

as calculated by the ECB and the European Commission (EC). Both include, besides EU

Member States, major industrialised countries and emerging economies (19 and 20 partner

countries for the EC and ECB, respectively). It is however noticeable that China is not

included in the EC’s basket, while it is the largest trading partner of the euro area since


8

2007 based on the ECB index. Furthermore, South Korea is not featured in the European

Commission’s index, while Turkey is. The scoreboard indicators of the EC (see Section

3.2) are based on this group of trading partners. This different composition of the basket

explains higher weights (in absolute term) assigned in the EC indicators for the remaining

partners such as the United States and United Kingdom.

Chart 1: Top 10 trading partners of the euro area in the narrow EER groups

(percentages)

0

5

10

15

20

25

ECB EER‐20 (2007‐09) IC36 (2008)

Note:

ECB (2007-2009) are trade weights in the period indicated referring to a group of 20 trading partners. IC36 (2008) are trade weights of the European Commission in 2008 referring to a group of 19 trading partners.

Data shown in Chart 2 refer to the larger groups of trading partners for the euro area. To

account also for smaller partners (in terms of trade) the BIS calculates the EERs of the

euro area vis-à-vis a group of 42 partner countries (subtracting the euro area Member

States from the group of 61 partners), while the ECB calculates EERs for the euro area

vis-à-vis 40 partner countries. Finally, the EC includes 24 partner countries in its broad

indicator for the euro area.


July 2012 9

China is ranked to be the biggest competitor for the euro area according to the ECB and

BIS. In the EC indicator, China only is the third largest competitor following the United

States and United Kingdom, as the EC indicator does not reflect import trade weights.

Moreover, it is striking that Russia is the fourth largest trading partner according to the

EC, while it has the ninth position in the BIS and ECB indices.

Chart 2: Top 10 trading partners of the euro area in the broad EER groups

(percentages)

0

2

4

6

8

10

12

14

16

18

20

China UnitedStates

UnitedKingdom

Japan Switzerland Poland CzechRepublic

Sweden Russia Turkey

BIS (2008‐10) ECB (2007‐09) EC(2008)

Note: BIS (2008-2010) are trade weights in the period indicated referring to a group of 42 trading partners. ECB (2007-2009) are trade weights in the period indicated referring to a group of 40 trading partners. EC (2008) are trade weights of the European Commission in 2008 referring to a group of 24 trading partners.

2.3 WEIGHTING METHOD

Generally, EER indicators based on Turner and Van’t dack (1993) gauge three types of

competition between a domestic country i and a foreign country j:

The import competition between countries i and j in market i;

The export competition between countries i and j in market j;

The competition of countries i and j in all other markets.

The overall weight of a partner country considered in a group of trading partners is

obtained by summing up the weighted average of import and export weights. Calculating


10

the weight for imports is straightforward, as it consists of the simple weight of a partner

relative to all partners’ imports.

It is different for the export weights, because the method generally applied includes the

competition arising from a partner’s domestic production and third market effects.

Accounting for third market effect is important, as is for instance demonstrated by the

development of the euro area’s trade with China (see Schmitz et al., 2012). In the ECB

indices, China is the largest trading partner of the euro area in the period 2007-09, also

because of the competition between the euro area and China in all other markets. Hence,

on the one hand, the euro area faces competition from Chinese manufacturers on the

Chinese market; while on the other hand, competition between euro area and Chinese

exporters takes place on third markets.

The third market effect is taken into account in all EERs discussed in this paper. However,

import competition between two countries in the domestic market is not considered in the

EC’s EERs.

2.4 UPDATES OF TRADE WEIGHTS

Both the ECB and BIS use three-year non-overlapping averages of trade data which are

updated every three years, while the European Commission updates the weights on an

annual basis using yearly data, with the latest weights available up to 2008. Finally, the

IMF does not update the weights at a regular frequency, but at infrequent intervals.

In particular for the ECB, updates of trade weights for the euro area occur in two

instances. One is the enlargement of the euro area to new member countries, which

involves the enlargement of the basket of currencies in the narrow and larger groups; the

second case is the regular updating of the underlying trade weights.

In the first case, new codes are assigned to the narrow and broad groups of trading

partners, which are revised backwards, with the exception of series accounting for the

historical development of the euro area;5 for the Harmonised Competitiveness Indicators

(HCIs) calculated for single euro area countries, the composition of the groups remain

stable, as the basket includes all euro area member states separately. Therefore, the

5 These series change only from the date of the enlargement and are not revised backwards due to the changed composition.


July 2012 11

composition of the narrow group of the HCI counts 37 countries (57 countries for the

broad group), whether or not a new country joins the euro area.6 In the case of regular

updates of manufacturing trade data, however, the time series changes over the entire

period due to data revisions and chain-linking.

2.5 DEFLATORS

The deflators used for the calculation of the real effective exchange rates as shown in

Table 3, widen the scope of the indicators to measure countries’ price and cost

competitiveness. Both the European Commission and ECB calculate real effective

exchange rates, based on:

(1) Consumer price (CPI and HICP where available);

(2) the GDP deflator (PGDP);

(3) Unit Labour Costs in the total economy (ULCE or ULCT); and

(4) Unit Labour Costs in the manufacturing sector (ULCM).

The main feature of these deflators is the underlying harmonisation of concepts. For

example, for all European Union country data the Harmonised Index of Consumer Prices

is used, while similar national consumer price indices are employed for all other trading

partners. GDP deflators are derived from quarterly national accounts. Unit labour costs are

calculated as the ratio of the compensation per employee and labour productivity, with

labour productivity measured as GDP at constant prices divided by the total number of

employees. The European Commission also provides data based on price deflator of

exports of goods and services (PX), while Producer prices-based (PPI) EERs are available

for the ECB indicators of the narrow-group. BIS indicators are based on CPI deflators,

while the IMF calculates CPI deflated EERs for a broad group and ULC-deflated EERs

for a narrow set of industrial countries.

6 Currently, the narrow group for the HCI includes 17 euro area member states and 20 non euro area trading partners. The broad group for the HCI extends the number of countries to 40 non-euro area partners.


12

Table 3: Overview of deflators

Institution BIS IMFMonthly Quarterly Monthly Monthly Quarterly

narrow/broad narrow/broad narrow/broad broad narrow

DeflatorsCPI, PPI*

GDP deflator, ULCM,

ULCE/ULCT, PX**

CPI CPI ULC

ECB/European Commission

* Only ECB ** Only European Commission

3 QUANTITATIVE EVIDENCE

In this section, we analyse to what extent there are differences in the effective exchange

rate indicators published by different international institutions and which methodological

features drive those differences. Given the distinction between groups of trading partners,

we perform two separate comparisons of available EERs: for the broad and for the smaller

groups of trading partners.

3.1 EURO EFFECTIVE EXCHANGE RATES

We compare REERs for broad groups of trading partners based on CPI deflators. This

analysis is particularly interesting because it allows explaining the differences of

methodologies between different data sources. Euro real effective exchange rates deflated

by consumer price indices are visible in Chart 3, while the cross-correlations over the

period January 1999 until December 2011 are shown in Table 4. In general there is a very

high correlation between these indices, the highest being between the ECB and BIS

indices, which are also most comparable from a methodological point of view. In the

period from 2004 until 2009, one can observe a slightly lower level of the index computed

by the European Commission, which most likely arises from the fact that less partner

countries are included in this index.


July 2012 13

Chart 3: Selected euro real effective exchange rates deflated by CPI (January 1999–December 2011)

80

85

90

95

100

105

110

115

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

ECB‐EER‐40 EC‐IC‐41 BIS broad IMF broad

Source: ECB, European Commission, BIS, IMF. Note: A decline reflects a depreciation of the euro, while a rise shows an appreciation of the euro.

Table 4: Correlation matrix of broad REER-CPI indicators (January 1999–December 2011)

ECB‐EER‐40 IC41 B61 IMF broad

ECB‐EER‐40 100.00%

IC41 99.08% 100.00%

B61 99.74% 98.99% 100.00%

IMF broad 99.49% 99.65% 99.22% 100.00% Source: BIS, ECB, European Commission, IMF.

More heterogeneity is noticeable among REERs for smaller groups of trading partners,

where unit labour costs (ULCT) in the total economy are used as the deflator (Chart 4). In

fact, over the period January 1999 to December 2011, a divergence of the indices is

visible from 2004 onwards. In December 2011 the ECB index reaches the lowest value

among the three indices considered, thus indicating a real depreciation of the euro since

1999, while the other two indices point to a real appreciation of the euro. Again, the

explanation lies in the trading partners considered in this group of countries, since the

ECB index also includes emerging market economies where unit labour costs tend to rise

faster than in advanced economies.


14

Chart 4: Selected euro real effective exchange rates deflated by ULCT (January 1999–December 2011)

80

85

90

95

100

105

110

115

120

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

ECB‐EER‐20‐ULCT EC‐IC36‐ULCT IMF‐narrow‐ULCT

Sources: ECB, European Commission, IMF. Note: A decline reflects a depreciation of the euro, while a rise shows an appreciation of the euro.

Chart 5: Selected euro real effective exchange rates deflated by GDP deflator (January 1999–December 2011)

80

85

90

95

100

105

110

115

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

ECB‐EER20‐GDPD EC‐IC36‐GDPD

Sources: ECB, European Commission. Note: A decline reflects a depreciation of the euro, while a rise shows an appreciation of the euro.


July 2012 15

A similar pattern emerges when comparing euro real effective exchanges rates deflated by

GDP deflators as computed by the ECB and European Commission (Chart 5) and when

unit labour costs of the manufacturing sector are used as deflators (not shown in a chart).

3.2 SCOREBOARD INDICATORS FOR EURO AREA MEMBER STATES

In this section, we follow the approach of the European Commission when calculating the

scoreboard of the EU’s Macroeconomic Imbalance Procedure (see European Commission,

2012). In the scoreboard, percentage changes in the real effective exchange rates (deflated

by CPI) of EU countries over a three year period are reported. The latest version of the

scoreboard in the European Commission’s Alert Mechanism Report (2012) covers the

period 2007 until 2010, while in Table 5 we focus on the most recent period 2008 to 2011.

The benchmark used in the scoreboard is the European Commission’s IC36 index (in the

first column of Table 5), which is the smaller of the EC’s trading partner groups. We

compare this indicator with various CPI deflated REERs for the euro area Member States

(Table 5).

Looking at Table 5, a few regularities emerge: the three-year percentage change based on

the IC36 indicator shows – for the majority of countries considered – the lowest values (if

negative) and the highest values (if positive) across all indicators displayed. Moving to a

wider group of trading partners (e.g. the IC41) reveals more negative or less positive

numbers, respectively. The same pattern also emerges when moving from the ECB’s

smaller to the larger group of trading partners. For instance, Germany shows a value of

minus 3.8% based on the IC36 index, whereas it exceeds minus 5% in the ECB-40 and

BIS (broad) indices. The positive value for the Slovak Republic is highest in IC36, and it

is also higher in the EER-20 than in EER-40. This implies that differences in the

composition of trading partner groups have a consistent impact on the resulting indicators.


16

Table 5: Scoreboard indicators for euro area Member States, 2008-11 (percentages)

IC36 ECB‐20 ECB‐40 IC41 BIS broad IMF

Austria ‐1.1 ‐1.6 ‐2.1 ‐1.9 ‐2.4 ‐1.6

Cyprus ‐0.7 ‐1.9 ‐2.5 ‐1.7 ‐2.8 ‐1.7

Estonia 0.8 0.7 0.0 ‐0.6 ‐0.6 NA

Finland ‐1.2 ‐2.0 ‐2.9 ‐2.8 ‐5.1 ‐4.4

France ‐3.3 ‐3.6 ‐4.3 ‐4.1 ‐5.0 ‐3.5

Germany ‐3.8 ‐4.8 ‐5.5 ‐4.6 ‐6.0 ‐4.7

Greece 2.9 1.2 0.8 1.9 1.1 1.9

Ireland ‐9.1 ‐10.0 ‐10.5 ‐9.7 ‐11.5 ‐11.1

Italy ‐2.1 ‐2.8 ‐3.6 ‐3.1 ‐3.7 ‐2.6

Malta ‐3.8 ‐2.8 ‐3.4 ‐3.8 ‐3.8 ‐3.4

Netherlands ‐1.7 ‐4.2 ‐4.9 ‐2.5 ‐4.5 ‐2.2

Portugal ‐2.2 ‐2.2 ‐2.8 ‐2.9 ‐2.5 ‐1.9

Slovak Republic 4.2 3.0 2.5 3.3 2.7 4.0

Slovenia ‐0.5 ‐1.6 ‐1.9 ‐1.9 ‐2.5 NA

Spain ‐1.4 ‐2.3 ‐2.9 ‐2.4 ‐3.3 ‐1.7 Sources: own calculations based on BIS, ECB, European Commission and IMF. Note: Scoreboard indicators calculated as percentage change of average REER in year 2011 relative to average REER in year 2008. A negative value reflects a gain in competitiveness, while a positive value shows a loss in competitiveness.

In Table 6, differences in the scoreboard-approach based indicators are highlighted in a

more systematic way. We compute scoreboard indicators as in Table 5, but at a yearly

frequency starting from 2002 (i.e the three-year change between 1999 and 2002).

Subsequently, we determine differences (in absolute value terms) between various

indicators and report the average difference for each country and overall.

The difference between ECB and EC EERs for the smaller group amounts to, on average,

0.9 percentage points (ECB-20 vis-à-vis IC36). A similar result is obtained when

comparing the smaller with the larger group of partners for the indicators of the European

Commission (IC36 vis-à-vis IC41). In contrast, the difference between the two ECB

indicators (ECB-20 and ECB-40), as well as the difference between the ECB-40 and the

BIS-B61 – which both follow a very similar methodology – reach a value of 0.6. This

suggests that the inclusion of the most important trading partners for the euro area such as

China (which is not considered in the IC36 index) has a sizeable impact on the indicators.

The largest difference with the other indicators is visible for the IMF (1.2 percentage

points in comparison to the ECB-40) which might be driven by the fact that the IMF


July 2012 17

updates its trade weights less frequently and considers a broader trade basis and set of

partner countries.

Table 6: Differences in scoreboard indicators 2002-2011 (averages, absolute value)

ECB‐20 vs

IC36

EC36 vs

IC41

ECB‐20 vs

ECB‐40

ECB‐40 vs

BIS broad

ECB‐40 vs

IMF

Austria 0.5 0.7 0.4 0.5 1.0

Cyprus 1.1 1.1 0.5 0.9 2.0

Estonia 1.0 1.7 1.0 0.5 NA

Finland 0.5 1.6 1.1 0.9 1.2

France 0.6 0.8 0.6 0.4 0.8

Germany 0.9 0.9 0.7 0.4 0.6

Greece 1.1 1.0 0.6 0.4 0.7

Ireland 1.0 0.6 0.6 1.5 1.8

Italy 0.7 0.9 0.7 0.3 0.6

Malta 1.1 0.8 0.6 0.9 1.5

Netherlands 1.9 0.6 0.7 0.6 1.8

Portugal 0.7 0.6 0.5 0.2 0.9

Slovak Republic 1.0 0.7 0.4 1.1 1.7

Slovenia 0.5 1.4 0.7 0.5 NA

Spain 0.7 0.8 0.7 0.3 1.1

Overall 0.89 0.94 0.64 0.63 1.22 Sources: own calculations based on BIS, ECB, European Commission and IMF. Note: Scoreboard indicators calculated as percentage change of average REER in year t relative to average REER in year t minus 3.

Equivalent results (however with larger differences due to more sizeable fluctuations in

the indices) are found if we consider indices deflated by ULCT or GDP deflators (not

presented in a table). All in all, Table 6 reveals that there are rather persistent differences

between various indicators. While these appear to be small in general, it would still be

desirable to follow the same methodology in constructing these indicators – in particular

as regards the composition of trading partners groups.

3.3 EFFECTIVE EXCHANGE RATES SIMULATIONS

To help identifying sources of divergences between different indices, we simulate

effective exchange rates with different sets of underlying trade weights based on ECB

methodologies and calculations. Chart 6 reveals that the number of trading partners

matters. In particular, moving from 12 trading partners to 20 trading partners (thus


18

including more emerging market economies, most noticeable China) leads to substantial

changes in the indices. As a large proportion of euro area trade is already covered by the

EER-20 group (about 80%), a further move to the EER-40 groups does not have a major

impact on the indices.

Chart 6: ECB euro real effective exchange rates deflated by CPI (January 1999–May 2012)

Source: ECB. In Chart 7, we isolate changes in the methodology regarding trade weights. For the EER-

20 indicators deflated by CPI, we first exclude import weights (hence we only consider

double export weights, following the European Commission’s methodology). We observe

that this has only a very marginal impact on the REER index, as in general those countries

that are the main export competitors for the euro area also are important sources of

imports (Schmitz et al., 2012).

Second, we present evidence on the importance of updating trade weights regularly. To

this end, we construct an index that is based over the entire time horizon on the trade

weights of the period 1995-97. Chart 7 shows a considerable divergence of this index

from the official ECB EER-20 index since 2005. The deviation seems to be driven by the

shift in trade weights towards emerging market economies and non-euro area EU Member

States (most prominently, the rise of China, as shown in Schmitz et al., 2012).


July 2012 19

Chart 7: ECB euro real effective exchange rates (EER-20) deflated by CPI, various trade weights (January 1999–March 2012)

80

85

90

95

100

105

110

115

120

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Official EER‐20‐CPI 1995‐97 weights Double export weights only

Source: ECB and own calculations.

Chart 8: Real euro EERs deflated by consumer price indices, different trade weights (January 1999-March 2012)

Source: ECB and Schmitz (2012). Note: A downward movement reflects a depreciation of the euro, while an upward movement indicates an appreciation.


20

Chart 8 contains three euro real effective exchange rates deflated by CPI: the official

REER-20 (based on manufacturing trade weights) is compared to the same indicator based

on trade in services and to an index combing both sets of trade weights.7 In the period

since January 1999, the services based REER indicates a loss in price competitiveness of

about 3%, while the manufacturing (official) ECB index indicates a competitiveness gain

of 2.7%. The combined index indicates a slight improvement in competitiveness by 1.3%.

Including trade in services in the weighting scheme leads to difference in the trade weights

(see Schmitz, 2012). For example, the United States and United Kingdom have a much

higher weight in services compared to manufacturing trade, while the opposite is true for

China. These patterns have an impact on the developments of real effective exchange rate

indicators. This is in particular true at the individual Member State level where services

trade make up a dominant share of total trade for some countries.

4 CONCLUSION

This paper highlights different methodological approaches to calculating REERs. In

general, there is a broad consensus on how to construct these indicators. However, there

are observable differences in the REER indicators due to their underlying methodologies.

In particular, the choice of partner countries is heterogeneous among indicators published

for the euro area. As a consequence, certain events, such as the latest developments of

trade with China, taking into account the competition on third markets and China’s

important role as an exporter to the euro area, is not reflected in all available indicators.

Furthermore, trade data used in the weighting schemes are not harmonised across different

institutions. Finally, the development of countries’ competitiveness may not reflect the

most up-to data due to different updating schedules.

Consequently, exchange rate-based competitiveness indicators as computed by different

institutions may not always deliver the same policy messages. Our analysis supports a

further move towards harmonisation of methodologies, in particular as regards the

composition of trading partners groups. We advocate the inclusion of those countries in

the indices that represent the major trading partners of the euro area according to the most

updated data.

7 These are based on Schmitz (2012).


July 2012 21

REFERENCES

Bayoumi, T., Lee, J. and Jayanthi, S. (2005), “New rates from new weights”, IMF Working Paper, WP/05/99. European Commission (2012), “Scoreboard for the surveillance of macroeconomic imbalances”, European Economy Occasional Paper, No 92. Klau, M. and Fung, S.S. (2006), “The New BIS Effective Exchange Rate Indices”, BIS Quarterly Review, March. Schmitz, M. (2012), “Experimental effective exchange rates based on trade in services”, mimeo, European Central Bank. Schmitz, M., De Clercq, M., Fidora, M., Lauro, B. and Pinheiro, C. (2012), “Revisiting the effective exchange rates of the euro”, ECB Occasional Paper, No 134. Turner, P. and Van’t dack, J. (1993), “Measuring international price and cost competitiveness”, BIS Economic Papers, No 39.

Euro area exchange rate-based competitiveness indicators: a … · 2012-10-23 · The different...

Documents

Transcript of Euro area exchange rate-based competitiveness indicators: a … · 2012-10-23 · The different...